News overnight that the United States and China would resume trade talks has understandably lifted the spirits of global investors. To my mind, the new twist in the trade saga may well suggest one thing: Trump has conceded defeat.
Why would Trump cave? Because of the growing signs that the trade war has inflicted “friendly fire” on America’s own manufacturing sector.
As seen in the chart below, up until recent months the trade war appears to have had a greater immediate effect on other economies in Asia and Europe. This time last year, for example, the Markit manufacturing index had slumped to around 50 for China, but was still at a comfortable 55 in the United States. Europe and Japan’s manufacturing slide came some months later, but it has been the US index that has dropped most notably in recent months.
Indeed, the Markit US manufacturing dipped below 50 in August, for the first time in three years.
US President Trump might have once thought that a strong show of force – such as going ahead with threatened tariffs increases – might have brought China to the negotiating table and extracted large trade concessions. It did not. Now that threat has not worked, Trump faces the choice of either conceding or increasingly risk the US economy by jacking up tariffs even more.
Another option Trump might have contemplated in recent months was just to let the trade war drag out. Even if he can’t strike a deal with China, he might have thought that continued sabre rattling at least had some political payoff amongst his heartland voters.
To my mind, the recent weakening in some US economic indicators – especially the manufacturing outlook – suggests that simply allowing the trade war to drag on is leading to a new set of political risks for Trump, namely a severe slowing in the economy and potential recession. Indeed, I’ve come to believe that if current trade uncertainty persists for much longer, a US recession by early 2020 seems more likely than not. In turn that would severely dent Trump’s chances of a second term in office.
Another factor to consider is that the Democrats are now also very tough on China, limiting Trump’s ability to differentiate in this policy area. He might conclude he needs to change track – striking a deal and neutralising the China issue for some time, allowing him to focus on other more controversial issues like immigration and further tax cuts.
Time will tell, but I suspect Trump is softening up to strike a deal with China.
It may not be as strong a deal as he would have ideally liked, but would likely still trumpet it as a victory nonetheless. If so, bonds yields could well rebound somewhat in coming months as the case for aggressive Fed rate cuts (still priced into the market) is undermined. That said, I suspect global equity markets could also rejoice, taking the rise in their stride.
A trade deal might also allow the Reserve Bank of Australia a little more time to assess the economy. As most of the local economy’s slowing is home grown, however, I still think the RBA will cut rates to 0.5% by early next year even if Trump throws in the towel.